PART FOUR

CENTRAL
BANKING AND
THE CONDUCT
OR MONETARY
POLICY

Copyright © 2012 Pearson Education.

All rights reserved.
CHAPTER 9

Central Banks:
A Global
Perspective

Copyright © 2012 Pearson Education.

All rights reserved.
 Chapter Preview

Central banks are the government authorities

in change of monetary policy. For example, in
the U.S., the central bank is the Federal
Reserve System and in Europe it is the
European Central Bank. Although we
typically hear about central banks in
connection with interest rates, their actions
also affect credit, the money supply, and
inflation (just to name a few areas).
© 2012 Pearson Education. All rights reserved. 9-3
 Chapter Preview

In this chapter, we will more closely examine

the structure of the major central banks
throughout the world. We start with the Fed,
looking at both the formal and informal power
structure. We then move to the other central
banks.

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 Origins of the Federal Reserve
System
 Resistance to establishment of a central bank
─ Fear of centralized power
─ Distrust of moneyed interests
 No lender of last resort
─ Nationwide bank panics on a regular basis
─ Panic of 1907 so severe that the public was convinced
a central bank was needed
 Federal Reserve Act of 1913
─ Elaborate system of checks and balances
─ Decentralized

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 Structure of The Federal Reserve
System
 The writers of the Federal Reserve Act wanted
to diffuse power along regional lines
 Federal Reserve System include the following
entities
─ The 12 Federal Reserve banks
─ The Board of Governors of the Federal Reserve
System
─ The Federal Open Market Committee (FOMC)
─ The Federal Advisory Council
─ Around 2,900 member commercial banks
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 FIGURE 9.1 Federal Reserve
System

Source: Federal Reserve Bulletin.

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 Federal Reserve Banks

 Quasi-public institution owned by private

commercial banks in the district that are members
of the Fed system
 Member banks elect six directors for each district;
three more are appointed by the Board of
Governors
 Together, these nine directors appoint the president
of the bank subject to approval by Board of
Governors

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 Functions of the Federal
Reserve Banks
 Clear checks
 Issue new currency
 Withdraw damaged currency from circulation
 Administer and make discount loans to
banks in their districts
 Evaluate proposed mergers and applications
for banks to expand their activities
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 Member Banks
 All national banks are required to be members
of the Federal Reserve System
 Commercial banks chartered by states are not
required but may choose to be members
 Depository Institutions Deregulation and
Monetary Control Act of 1980 subjected all
banks to the same reserve requirements as
member banks and gave all banks access to
Federal Reserve facilities

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 Board of Governors of the
Federal Reserve System
 Seven members headquartered in Washington,
D.C.
 Appointed by the president and confirmed by the
Senate
 14-year non-renewable term
 Required to come from different districts
 Chairman is chosen from the governors and
serves four-year term

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 Federal Open Market
Committee (FOMC)
 Meets eight times a year
 Consists of seven members of the Board of
Governors, the president of the Federal Reserve
Bank of New York and the presidents of four other
Federal Reserve banks
 The chairman of the Board of Governors is also
chair of FOMC
 Issues directives to the trading desk at the Federal
Reserve Bank of New York
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 How Independent is the Fed?
 Instrument and goal independence.
 Independent revenue
 Fed’s structure is written by Congress, and is subject to
change at any time.
 Presidential influence
─ Influence on Congress
─ Appoints members
─ Appoints chairman although terms are not concurrent

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 Structure and Independence of
The European Central Bank
 The ESCB encompasses the ECB and the National Central
Banks of the 27 EU member states
 The Eurosystem comprises of the ECB and the NCBs of
only the sixteen countries that have adopted the euro
 The decision-making process at the EMU takes place at
three levels
─ The Governing Council, the Executive Board and the
General Council

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 Governing Council Executive
Board and General Council
 Governing Council
─ The supreme decision-making body of the ECB,
comprises the six members of the Executive Board,
plus the governors of the National Central Banks of the
16 Euro area nations
─ Formulate the monetary policy for the Euro area
 Executive Board
─ President, vice-president and four other members
─ Ensure the day-to-day implementation of the
monetary lines of the Governing Council

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 Governing Council Executive
Board and General Council
 The General Council
─ President, vice-president of the ECB,
representatives of the 16 Euro area countries
and the 11 non-Euro zone EU Member States.
─ Performs advisory tasks to the ECB, collects
statistical information and standardizes the
accounting operations of the NCBs

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 How Do National Central Banks
Operate Within the Eurosystem
 Play an essential role in the ESCB
 Exercise powers delegated by the
Governing Council
 Deutsche Bundesbank
─ Till 2008 Bundesbank had nine regional offices
and 47 branches throughout Germany

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 How does the ECB differ
from the Bundesbank?
 Implements the Eurosystem monetary policy as
laid down in the EC Treaty
 Clears house for its member banks and the
banker’s banker
 The Bundesbank is the state’s banker and Federal
Government’s fiscal agent
 Manages the currency reserves of Germany
 Cooperates with other international institutions

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 How Independent is the
ECB?
 Most independent in the world
 Members of the Executive Board have long terms
 Determines own budget
 Less goal independent
─ Price stability
 Charter cannot by changed by legislation; only by revision
of the Maastricht Treaty

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 Central Banks Round The World

 Bank of Canada
─ Essentially controls monetary policy
 Bank of England
─ Has some instrument independence
 Bank of Japan
─ Recently (1998) gained more independence
 Central Banks in Transition Economies
─ Czech, Bulgarian and Hungarian central banks

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 Central Banks in Developing
Countries and Emerging Economies

 The degree of independence of their central

banks highly relates to the level of
development of the financial sector and
political institutions
 One main barrier is the low level of
capitalization and their inability to generate
sources of revenue.

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 Central Banks in Developing
Countries and Emerging Economies

 People’s Bank of China

 Multinational Central Banks in Developing
countries
 Central Bank Reforms in South America
 Currency Unions in Developing Nations
 The Trend Toward Greater Independence

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 Explaining Central Bank Behavior

 Theory of bureaucratic behavior:

objective is to maximize its own welfare
which is related to power and prestige
─ Fight vigorously to preserve autonomy
─ Avoid conflict with more powerful groups
 Does not rule out altruism

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 Case for Independence

 Political pressure would impart an inflationary bias

to monetary policy
 Political business cycle
 Could be used to facilitate Treasury financing of
large budget deficits: accommodation
 Too important to leave to politicians—the principal-
agent problem is worse for politicians

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 Case Against Independence

 Undemocratic
 Unaccountable
 Difficult to coordinate fiscal and monetary
policy
 Has not used its independence successfully

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 Chapter Summary
 The Federal Reserve System was created
in 1913 to lessen the frequency of bank
panics.
 The Federal Reserve is more independent
than most agencies of the U.S. government
but is still subject to political pressure.

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 Chapter Summary cont.
 The European System of Central Banks has a
fairly similar structure to the Federal Reserve
System.
 Each member country has a National Central
Bank, and an Executive Board of the European
Central Bank being located in Germany.
 The Governing Council is made up of 6 members
of the Executive Board, and the Presidents of the
National Central Banks.

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 Chapter Summary cont.
 Most developing nations and transition economies
have reformed their central banks and granted
them increasing levels of independence.
 Central banks are gaining more independence
throughout the world. Greater independence has
been granted to the Bank of England and Bank of
Japan.
 What are the pros and cons for independent
banks?

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